The dividend payout ratio is the ratio of total dividends paid to shareholders relative to the net income of the company. Investors can use the dividend payout formula to gauge what fraction of a company’s net income they could receive in the form of dividends.
While a company will want to retain some earnings to reinvest or pay down debt, the extra profit may be paid out to investors as dividends. As such, investors will want a way to calculate what they can expect if they’re a shareholder.
Understanding Dividends and How They Work
Before calculating potential dividends, investors will want to familiarize themselves with what dividends are, exactly.
A dividend is when a company periodically gives its shareholders a payment in cash, or additional shares of stock, or property. The size of that dividend payment depends on the company’s dividend yield and how many shares you own.
Many investors look to buy stock in companies that pay them as a way to generate regular income in addition to stock price appreciation. A dividend investing strategy is one way many investors look to make money from stocks and build wealth.
Investors can take their dividend payments in cash or reinvest them into their stock holdings. Not all companies pay dividends, and those that do tend to be large, established companies with predictable profits — blue chip stocks, for example. If an investor owns a stock or fund that pays dividends, they can expect a regular payment from that company — typically, each quarter. Some companies may pay dividends more frequently.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
Pros and Cons of Investing in Dividend Stocks
Since dividend income can help augment investing returns, investing in dividend stocks — or, stocks that tend to pay higher than average dividends — is popular among some investors. But engaging in a strategy of purchasing dividend stocks has its pros and cons.
As for the advantages, the most obvious is that investors will receive dividend payments and see bigger potential returns from their holdings. Those dividends, in addition to stock appreciation, allow for two potential ways to generate returns. Another benefit is that investors can set up their dividends to automatically reinvest, meaning that they’re holdings grow with no extra effort.
Potential drawbacks, however, are that dividend stocks may generate a higher tax burden, depending on the specific stocks. You’ll need to look more closely at whether your dividends are “ordinary” or “qualified,” and dig a little deeper into qualified dividend tax rates to get a better idea of what you might end up owing.
Also, stocks that pay higher dividends often don’t see as much appreciation as some other growth stocks — but investors do reap the benefit of a steady, if small, payout.
What Is the Dividend Payout Ratio?
The dividend payout ratio expresses the percentage of income that a company pays to shareholders. Ratios vary widely by company. Some may pay out all of their net income, while others may hang on to a portion to reinvest in the company or pay off debt.
Generally speaking, a healthy range for payout ratios is from 35% to 55%. There are certain circumstances in which a lower ratio might make sense for a company. For example, a relatively young company that plans to expand might reinvest a larger portion of its profits into growth.
How to Calculate a Dividend Payout
Calculating your potential dividend payout is fairly simple: It requires that you know the dividend payout ratio formula, and simply plug in some numbers.
Dividend Payout Ratio Formula
The simplest dividend payout ratio formula divides the total annual dividends by net income, or earnings, from the same period. The equation looks like this:
Dividend payout ratio = Dividends paid / Net income
Again, figuring out the payout ratio is only a matter of doing some plug-and-play with the appropriate figures.
Dividend Payout Ratio Calculation Example
Here’s an example of how to calculate dividend payout using the dividend payout ratio.
If a company reported net income of $120 million and paid out a total of $50 million in dividends, the dividend payout ratio would be $50 million/$120 million, or about 42%. That means that the company retained about 58% of its profits.
Or, to plug those numbers into the formula, it would look like this:
~42% = 50,000,000 / 120,000,000
An alternative dividend payout ratio calculation uses dividends per share and earnings per share as variables:
Dividend payout ratio = Dividends per share / Earnings per share
A third formula uses retention ratio, which tells us how much of a company’s profits are being retained for reinvestment, rather than paid out in dividends.
Dividend payout ratio = 1 – Retention ratio
You can determine the retention ratio with the following formula:
Retention ratio = (Net income – Dividends paid) / Net income
You can find figures including total dividends paid and a company’s net income in a company’s financial statements, such as its earnings report or annual report.
Get up to $1,000 in stock when you fund a new Active Invest account.**
Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.
Why Does the Dividend Payout Ratio Matter?
Dividend stocks often play an important part in individuals’ investment strategies. As noted, dividends are one of the primary ways stock holdings earn money — investors also earn money on stocks by selling holdings that have appreciated in value.
Investors may choose to automatically reinvest the dividends they do earn, increasing the size of their holdings, and therefore, potentially earning even more dividends over time. This can often be done through a dividend reinvestment plan.
But it’s important to be able to know what the ratio results are telling you so that you can make wise decisions related to your investments.
Interpreting Dividend Payout Ratio Results
Learning how to calculate dividend payout and use the payout ratio is one thing. But what does it all mean? What is it telling you?
On a basic level, the dividend payout ratio can help investors gain insight into the health of dividend stocks. For instance, a higher ratio indicates that a company is paying out more of its profits in dividends, and this may be a sign that it is established, or not necessarily looking to expand in the near future. It may also indicate that a company isn’t investing enough in its own growth.
Lower ratios may mean a company is retaining a higher percentage of its earnings to expand its operations or fund research and development, for example. These stocks may still be a good bet, since these activities may help drive up share price or lead to large dividends in the future.
💡 Quick Tip: How to manage potential risk factors in a self directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Paying attention to trends in dividend payout ratios can help you determine a dividend’s sustainability — or, the likelihood a company will continue to pay dividends of a certain size in the future. For example, a steadily rising dividend payout ratio could indicate that a company is on a stable path, while a sudden jump to a higher payout ratio might be harder for a company to sustain.
That’s knowledge that may be put to use when trying to manage your portfolio.
It’s also worth noting that there can be dividend payout ratios that are more than 100%. That means the company is paying out more money in dividends than it is earning — something no company can do for very long. While they may ride out a bad year, they may also have to lower their dividends, or suspend them entirely, if this trend continues.
Dividend Payout Ratio vs Dividend Yield
The dividend yield is the ratio of a stock’s dividend per share to the stock’s current price:
Dividend yield = Annual dividend per share/Current stock price
As an example, if a stock costs $100 and pays an annual dividend of $7 the dividend yield will be $7/$100, or 7%.
Like the dividend payout ratio, dividend yield is a metric investors can use when comparing stocks to understand the health of a company. For example, high dividend yields might be a result of a quickly dropping share price, which may indicate that a stock is in trouble. Dividend yield can also help investors understand whether a stock is valued well and whether it will meet the investor’s income needs or fit with their overall investing strategy.
Dividend Payout Ratio vs Retention Ratio
As discussed, the retention ratio tells investors how much of a company’s profits are being retained to be reinvested, rather than used to pay investors dividends. The formula looks like this:
Retention ratio = (Net income – Dividends paid) / Net income
If we use the same numbers from our initial example, the formula would look like this:
~58% = (120,000,000 – 50,000,000) / 120,000,000
This can be used much in the same way that the dividend payout ratio can, as it calculates the other side of the equation — how much a company is retaining, rather than paying out. In other words, if you can find one, you can easily find the other.
The dividend payout ratio is a calculation that tells investors how much a company pays out in dividends to investors. Since dividend stocks can be an important component of an investment strategy, this can be useful information to investors who are trying to fine-tune their strategies, especially since different types of dividends have different tax implications.
In addition, the dividend payout ratio can help investors evaluate stocks that pay dividends, often providing clues about company health and long-term sustainability. It’s different from other ratios, like the retention ratio or the dividend yield.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
How do you calculate your dividend payment?
To calculate your exact dividend payment, you’d need to know how many shares you own, a company’s net income, and the number of total outstanding shares. From there, you can calculate dividend per share, and multiply it by the number of shares you own.
Are dividends taxed?
Yes, dividends are taxed, as the IRS considers them a form of income. There may be some slight differences in how they’re taxed, but even if you reinvest your dividend income back into a company, you’ll still generate a tax liability by receiving dividend income.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.